Limits (and Expansions After Craft) of the Scope of Bankruptcy Court Power

12/05/2002

Introduction

In April 2002, the United States Supreme Court decided United States v. Craft which purported to expand the judicial reach of the federal courts.  United States v. Craft, 122 S. Ct. 1414 (April 2002).  Craft involved a dispute between the Internal Revenue Service and a delinquent taxpayer/husband.  Between the years of 1979 and 1986, the husband failed to file income tax returns, which resulted in the IRS assessing a large penalty.  The husband failed to pay the penalty, and pursuant to federal law, a tax lien attached to “all property and rights to property, whether real or personal, . . .” possessed by the husband.  Id. (quoting 26 U.S.C. § 6321 (1994)).

The property at issue in this case was the husband’s interest in certain real estate held with his wife as tenants by the entirety.  The husband transferred his interest in the property to his wife severing the tenancy of the entirety, but the IRS argued that the wife took subject to the tax lien.  The IRS advanced that, under the federal statute, the tax lien attached to the husband’s interest in the property.  The wife brought an action to quiet title to determine the federal government’s interest in the property, which led to the Craft opinion.

The basis for the wife’s claim is that the husband did not possess individual rights of ownership in the property for which the tax lien could attach.  Under Michigan law, land held in a tenancy by the entirety is not held individually but owned collectively by the tenancy.  The wife argued that because the husband did not have individual ownership rights to the property, a federal tax lien could not attach to any interest held by the husband in the property.  Thereby, when the husband transferred the property to the wife and severed the tenancy of the entirety, she took the property free and clear of any tax liens levied against the husband.

The issue in Craft centered on whether, for purposes of the federal tax lien statute, federal courts would turn to state law or federal law in defining what rights a person had in certain property.  Justice O’Connor, writing for the majority, held that the husband possessed rights in the entirety property under the federal tax statute.  Craft broadened the Michigan state law definition of property for federal tax liens in federal cases.  Under Michigan law, Justice O’Connor noted that the result would be different for state law creditors.  With individual rights in the property, the federal tax lien could attach to the husband’s portion of the entirety property, and the wife took subject to the federal government’s tax lien.

In a bankruptcy context, the importance of the Craft may not be readily apparent.  Upon taking a step back from the case, the impact on bankruptcy can be seen when examining the federal issue of this case.  The Craft court broadened the expanse of a federal statute allowing it to reach property not reachable before.[1]  Craft dealt less with an issue of tax but more in what types of property fell within the reach of a federal statute.  The Craft court expanded the reach of the federal tax statute to include property held as tenants in the entirety.  The impact in this case may be seen in a court’s willingness to give the Bankruptcy Code a more liberal read and bring more actions within the confines of the Bankruptcy Code and therefore within the jurisdiction of the Bankruptcy court.

In light of Craft, the scope of the Bankruptcy court’s power seems to be ever evolving.  The question persists whether the Craft decision will reinforce the trend of expanding bankruptcy power.  This article will focus on several areas where the bankruptcy court’s powers have expanded.  Part I of the article will focus on third party releases, bar orders, and injunctions in connection with Chapter 11 plans.  Part II will include a summary of sua sponte orders under § 105.  Part III looks to the court’s jurisdiction over non-debtor subsidiaries.  Part IV focuses on § 304 orders.  Part V examines the propriety of Mareva injunctions in bankruptcy court.  Part VI outlines substantive consolidation under § 105.  Part VII briefly looks at a recent court order as it relates to retention of professionals under § 328.  Finally, part VIII provides a brief overview of possible tax complications.

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